Stocks have barely flinched at the threat of the US defaulting on its debt. But a new analysis from JPMorgan says the lack of movement in markets thus far could mean things get even hairier as the potential day of default nears.
“In our view, the concern remains that equities will be slow to price the risk of a contested debt-ceiling rise and rising probabilities of technical default before sharply re-pricing these risks as we get closer to the X-date,” JPMorgan’s equity macro strategy team led by Dubravko Lakos-Bujas wrote in a note to clients on Monday.
President Biden is set to meet with Speaker of the House Kevin McCarthy at 5:30 p.m. ET on Monday to continue brokering a deal to extend the US debt limit. Talks between the two parties broke off on Friday in Biden’s absence and sent stocks lower.
But overall the moves downward have been limited as the S&P continues trading within its six month range of roughly 3,800-4,200.
Debt ceiling fears usually hurt stocks once the X-date, or day the U.S. is expected to not pay its obligations, is within two weeks, per Bank of America Research. Treasury Secretary Janet Yellen has circled that date as June 1 and warned of “serious harm to business and consumer confidence” if the debt extension comes too close to the deadline.
But that date isn’t seen as hard and fast, even by Yellen. Goldman Sachs projects the Treasury’s cash balance falling below $30 billion “by June 8-9.” In the past, $30 billion has been used to “project the deadline,” according to Goldman Sachs.
“Most parts of financial markets appear relatively sanguine regarding the approaching debt limit deadline,” Goldman Sachs’ economic research team led by Jan Hatzius wrote in a note to clients on Friday. “While we expect a deal to occur ahead of the deadline, we also expect a few more twists along the way, and suspect that markets are likely to price in additional risk before the debt limit is finally raised.”
In the past, the prolonged threats to the US not paying its debt obligations has weighed on stocks. In 2011, the S&P 500 tanked nearly 20% peak-trough amid ongoing debate in Washington.
While a 20% decline isn’t a baseline forecast, Evercore ISI argues a debt deal will come “in response to market pain.” UBS agrees, noting in its baseline scenario the S&P 500 will drop 5% by the end of the quarter but could see downside of up to 30% if the “very unlikely scenario” plays out and the US is not paying its coupons for a month.
The significant drop would mirror the moves downward seen in 2011, a time period some have likened to the current scenario.
But JPMorgan argues the impact on the overall economy could be very different this time around given the different backdrop. The “sharper risk” for stocks compared to 2011 comes as markets are already grappling with historically-high inflation, tightening credit conditions, and the most aggressive interest rate hike campaign in four decades.
Which is why, JPMoragn argues, flirting with debt default could have significant risks. Companies that have benefited from planned government spending like the Inflation Reduction Act and the CHIPS Act, could see downside risks as Biden might need to concede some spending in negotiations, per JPM.
“There are two major investment implications related to the debt ceiling and federal spending: 1) the potential for a violent risk- off move in equities as we get closer to the projected X-date of early June without a broadly supported resolution; and 2) the potential for federal spending cuts across key Biden legislative priorities,” JPMorgan’s equity macro strategy team wrote.
Josh is a reporter for Yahoo Finance.
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